Is South Korea Having an Asian Crisis Flashback?

The 1997/98 Asian financial crisis retro elements are truly, madly, deeply disturbing. Although Asian countries are now armed to the teeth with whopping levels of foreign exchange reserves to prevent a recurrence of those tumultuous days, I believe that the extreme levels of export reliance they have gone to build those reserves have come at a price. Very simply, who will all these Asian exporters sell to as America's consumer-driven economy hits the wall?

Today we revisit South Korea, one of the countries famously hit by crisis. As its foreign exchange reserves dwindled to nothing, it was forced to resort to the IMF. After years of exporting boatloads of stuff to hyperconsuming Americans and others, South Korea's reserves stand at about $240 billion. Still, its reserves have been declining in recent months as the country has tried to stem rising inflation by propping up the Korean won. Reuters now warns that things may be getting worse for the country as it has slid into a current account deficit for the first time since the Asian financial crisis. Declining export performance has in turn encouraged foreign investors to leave the country, worsening its balance of payments. Moreover, Korea has since become a heavily "financialized" economy with high levels of consumer indebtedness and high loan to deposit ratios compared to other countries in the region.

Ultimately, $240B should be enough to see the country through, though it will get a scare as it tries to sort out its current problems. It will be important to figure out if there are other export markets available. Once again, it begs the question of whether financial sophistication is so wonderful if it means increased vulnerability to credit events and the like:

South Korea urged banks on Monday to sell foreign assets to raise dollars and promised to use its currency reserves to shield lenders from the financial crisis engulfing the United States and Europe...

"Recently our financial institutions have begun experiencing troubles in securing foreign-exchange liquidity," [FinMin] Kang said at a meeting with executives from local commercial banks. "The government judges that we need to deal with the situation preemptively, while assuming the worst-case scenario." He did not elaborate on what preemptive action might include.

Kang repeated an earlier government pledge to give banks access to the country's foreign exchange reserves, the world's sixth largest at nearly $240 billion. "Banks need to take measures themselves such as selling foreign-currency securities and other assets to secure foreign exchange liquidity," Kang said...

South Korea looks more vulnerable than many Asian nations to the credit squeeze triggered by U.S. mortgage defaults last year that has triggered bank failures and nationalisations in the United States and Europe.

"This rush for foreign currency has been heightened not only due to the global credit squeeze but also because Korea has seen its current account falling sharply in recent months, even as investment outflow continues," analysts at UBS said in a note. "Although we are not expecting a banking crisis in Korea, the credit crunch is likely to be most severely felt in Korea among Asian economies given the highly leveraged Korean corporate and households."

Household debt in Korea has hit 82 percent of gross domestic product and 148 percent of disposable income. The bank loans-to-deposits ratio is at 139 percent after a lending spree between 2002 and 2007. Most Asian countries have loans-deposit ratios below 100 with Malaysia at around 74 percent and the Philippines at 57 percent.

The loans-to-deposit ratio of the four biggest Korean banks -- Kookmin Bank, Woori Finance Holdings, Shinhan Financial Group and Hana Financial Group -- ranged between 135-177 percent in the first quarter of 2008, Moody's Investors Service said.

"The current difficulties are a result of the global liquidity squeeze rather than risk issues at individual banks," said spokesman You Jung-youn at Kookmin, the biggest lender. "It is more about the country risk."

The government has spent almost $25 billion since March to support the won, which has lost 26 percent since December and appears headed for its worst year since the 1997-1998 Asian financial crisis when capital fled the region.

Korea is also on track to post its first annual current account deficit since that crisis and foreign investors notched up net stock sales of 30 trillion won ($24.57 billion) this year, already the highest on record. But analysts said comparisons with the Asian financial crisis were overblown. "It's different from the previous crisis because foreign reserves are now more than enough to cover short-term foreign debt," said Lim Ji-won, economist at JPMorgan Chase.

South Korean debt maturing in less than a year is worth about $210 billion. [A measure of reserve adequacy known as the Greenspan-Guidotti rule is being able to cover (usually external) debt due within a year.]